The following invention relates to a financial product and, in particular, to a system and method for providing investors with a financial product that provides a return that is linked to a specific return on an underlying asset.
It is an investment goal to achieve a return that is greater than prevailing market-based rates. Furthermore, a benchmark by which investment managers are typically evaluated is whether the investment strategy used by the manager has produced market-beating returns. For example, mutual funds that invest in stocks that are listed in the S&P 500 are considered to outperform the “market” if those funds outperform the S&P 500 index. Typically, the funds that beat market returns do so based on the fund manager's superior insights and stock-picking skills. The fund manager uses these superior skills and insights to identify the specific (non-market) return (i.e., alpha) associated with a particular stock to determine whether it meets the fund's selection criteria. Thus, it is desirable for investors and investment managers to be able to identify the specific return portion, or alpha component, of a stock's total return and apply an investment strategy to exploit this specific return.
A number of strategies exist for capturing alpha. For example, a fund manager may focus on small-capitalization stocks that are not followed by many market analysts and, with good research, may be able to build a portfolio of these small-capitalization stocks that beats the market. A potential drawback of this approach, however, is that small companies maybe more sensitive to economic downturns and their stocks may fall faster than the stocks of large companies in a recession.
Another strategy used to capture alpha is called a “long-short equity” strategy in which a fund manager buys underpriced stocks and sells overpriced stocks in equal amounts thereby eliminating industry and market effects and resulting in a return tied to the stocks' alpha. A drawback of this strategy is that it requires numerous transactions to establish and maintain a market neutral position. In addition, there is the expense in terms of the time and money needed to secure sufficient stock to borrow for the short positions. Also, there are many “common factor” exposures that affect many stocks. For a long-short equity manager to neutralize his/her position against these undiversifiable risks is extremely challenging and reduces the investor's focus on finding mispriced securities.
Accordingly, it is desirable to have a system and method for providing investors with a financial product that gives a return that is linked purely to a specific return on an underlying asset.